Investment In Associate Reviewer

Investment in Associate THEORIES 1. It is an entity over which the investor has significant influence. a. Associate b. Investee c. Venture capital organization d. Mutual fund 2. Which of the following statement best describes the term “significant influence”? a. The holding of a significant proportion of the share capital in another entity b. The contractually agreed sharing of control over an economic entity c. The power to participate in the financial and operating policy decisions of an entity d. The mutual sharing in the risks and benefits of a combined entity 3. Which of the following statements is true concerning significant influence? I. If an investor holds, directly or indirectly, less than 20% of the voting power of the investee, it is presumed that the investor does not have significant influence, unless such influence can be clearly demonstrated. II. If an investor holds, directly or indirectly, 20% or more of the voting power of the investee, it is presumed that the investor does have significant influence, unless it can be clearly demonstrated that this is not the case. III. A substantial or majority ownership by another investor does not necessarily preclude an investor from having significant influence. a. I, II, and III b. I and II only c. III only d. II only 4. Which of the following statements is incorrect concerning the equity method? a. The investment in associate is initially recorded at cost. b. The investment in associate is increased or decreased by the investor’s share of the profit or loss of the investee after the date of acquisition. c. The investor’s share of the profit or loss of the investee is not recognized in the investor’s profit or loss. d. Distributions received from the investee reduce the carrying amount of the investment. 5. Goodwill arising from an investment in associate is a. Included in the carrying amount of the investment and amortized over the useful life. b. Included in the carrying amount of the investment and not amortized. c. Excluded from carrying amount of the investment but charged to retained earnings. d. Excluded from carrying amount of the investment but charged to expense immediately. 6. If an associate has outstanding cumulative preference shares, held by outside interests, the investor computes its share of profit or loss a. After adjusting for preference dividends which were actually paid during the year.

b. Without regard for preference dividends. c. After adjusting for the preference dividends only when declared. d. After adjusting for the preference dividends, whether or not the dividends have been declared. 7. An investor shall discontinue the use of the equity method from the date I. The investor cease to have significant influence over an associate. II. The associates operates under severe long-term restrictions that significantly impair the ability to transfer funds to the investor. a. I only b. II only c. Both I and II d. Neither I nor II 8. If under the equity method, an investor’s share of losses of an associate equals or exceeds the carrying amount of an investment, which of the following statements is incorrect? a. The investor ordinarily discontinues its share of further losses. b. Additional losses are provided for a liability is recognized to the extent that the investor has incurred legal or constructive obligations or made payments on behalf of the associate. c. If the associate subsequently reports profit, the investor resumes its share of the profit without regard to the share of net loss not previously recognized. d. The investment is reported at NIL value. 9. When the investor discontinues the use of equity method because significant influence is lost, the investment in associate retained by the investor shall be measured at a. Fair value b. Carrying amount c. Amortized cost d. Original cost 10. When an entity holds between 20% and 50% of the voting power of an investee, which of the following statements is true? a. The investor must use the equity method. b. The investor should use the equity method unless circumstances indicate that it is unable to exercise significant influence over the investee. c. The investor must use fair value method unless it can be clearly demonstrated that the investor has significant influence over the investee. d. The investor must use the fair value method. 11. The equity method is not required to be applied when the associate has been acquired and held with a view to its disposal within a certain time period. What is period within which the associate must be disposed of? a. b. c. d.

Six months from the end reporting period Twelve months from the end of reporting period Twelve months from date of classification as held for sale In the near future

12. How is goodwill arising on the acquisition of an associate dealt with in the financial statements? a. b. c. d.

It is amortized. It is impairment tested individually. It is written off against profit or loss. Goodwill is not recognized separately within the carrying amount of the investment.

13. How is the impairment test carried out for an investment in associate? a. The goodwill is separated from the rest of the investment and is impairment tested individually. b. The entire carrying amount of the investment is tested for impairment by comparing the recoverable amount with carrying amount. c. The carrying amount of the investment shall be compared with the market value. d. The recoverable amounts of all investments in associates shall be assessed together to determine whether there has been an impairment on all investments. 14. What should happen when the financial statements of an associate are not prepared as of the same date as the financial statements of the investor? a. The associate shall prepare financial statements for the use of the investor at the same date as that of the investor. b. The financial statements of the associate prepared up to a different date shall be used as normal. c. Any major transactions between the date of the financial statements of the investor and that of the associate shall be accounted for. d. As long as gap is not greater than three months, there is no problem. 15. If there is any excess of the investor’s share of the net fair value of the associate’s identifiable assets and liabilities over the cost of the investment, that is, “bargain purchase”, how should that excess be treated? a. It should be included in other comprehensive income. b. It should be included in retained earnings. c. It should be included as income in the determination of the investor’s share of the associate’s profit or loss for the period. d. It should be disclosed separately as part of the investor’s equity. 16. An investor uses the equity method to account for an investment in ordinary shares. After the date of acquisition, the investment account of the investor would a. Not be affected by its share of the earnings or loss of the investee b. Not be affected by its share of the earnings of the investee, but be decreased by its share of the losses of the investee

c. Be increased by its share of the earnings of the investee, but not affected by its share of the losses of the investee d. Be increased by its share of the earnings of the investee, and decreased by its share of the losses of the investee 17. Under the equity method of accounting for investments, an investor recognizes its share of the earnings in the period in which the a. b. c. d.

Investor sells the investment Investee declares a dividend Investee pays dividend Earnings are reported by the investee in its financial statements

18. When the investor uses the equity method to account for investment in ordinary shares, the investment account will be increased when the investor recognizes a. b. c. d.

A proportionate interest in the net income of the investee A cash dividend received from the investee Periodic amortization of the goodwill related to the purchase Depreciation related to the excess of market value over carrying amount of the investee’s depreciable assets at the date of the purchase by the investor.

19. When an investor uses the equity method to account for investment in ordinary shares, cash dividends received by the investor from the investee shall be recorded as a. b. c. d.

Dividend income A deduction from the investor’s share of the investee’s profit A deduction from the investment account A deduction from the shareholders’ equity account, dividends to shareholder.

20. An investor uses the equity method to account for investment in ordinary shares. The purchase price implies a fair value of the investee’s depreciable asset in excess of the investee’s net asset carrying amount. The investor’s amortization of the excess a. b. c. d.

Decreases the investment account Decreases the goodwill account Increases the investment revenue account Does not affect the investment account

21. An investor uses the equity method to account for its 30% investment in ordinary shares of an investee. Amortization of the investor’s share of the excess of fair value over carrying amount of depreciable assets at the date of the purchase should be reported in the investor’s income statement as part of a. Other expense b. Depreciation expense

c. Equity in earnings of investee d. Amortization of goodwill 22. An investor uses the equity method to account for its purchase of another entity’s ordinary shares. On the date of acquisition, the fair value of the investee’s inventory and land exceeded their carrying amount. How do these excess of fair value over carrying amount affected the investor’s reported equity in earnings of the investee for the current year?

a. b. c. d.

Inventory excess Decrease Decrease Increase Increase

land excess decrease No effect Increase No effect

23. In its financial statements, an investor uses the equity method of accounting for its 30% ownership in an investee. At year-end, the investor has a receivable from the investee. How should the receivable be reported in the investor’s financial statements for the current year? a. None of the receivable should be reported, but the entire receivable should be offset against investee’s payable to the investor. b. Seventy percent of the receivable should be separately reported, with the balance offset against 30% of investee’s payable to the investor. c. The total receivable should be disclosed separately. d. The total receivable should be included as part of the investment in associate, without separate disclosure 24. When an investor purchases sufficient ordinary shares to gain significant influence over the investee, what is the proper accounting treatment of any excess of cost over the carrying amount of the net assets acquired? a. The excess remains in the investment account until it is sold. b. The excess is immediately expensed in the period in which the investment is made. c. The excess is amortized over the time period that is reasonable in the light of the underlying cause of the excess. d. The excess is charged to retained earnings at the time the investor resells the investment. 25. At the beginning of the current year, an investor acquired 30% of the ordinary shares of another entity. In the current year, the investee has net earnings which exceeded dividends paid. The investor mistakenly recorded these transactions using the cost method instead of the equity method of accounting. What effect would this have on investment account, net earnings and retained earnings, respectively?

a. b. c. d.

Overstae, overstate, overstate Overstate, understate, understate Understate, overstate, understate Understate, understate, understate

PROBLEM SOLVING 1. On July 1, 2018, Denver Company purchased 30,000 shares of Eagle Company’s 100,000 outstanding ordinary shares for P200 per share. On December 15, 2018, the investee paid P400,000 in cash dividend to the ordinary shareholders. The investee’s net income for the year ended December 31, 2018 was P1,200,000, earned evenly throughout the year. What amount of income from the investment should be reported in 2018? a. 360,000 b. 180,000 c. 120,000 d. 60,000 Solution 1 – Answer b Share in net income from July 1 to December 31, 2018 (1,200,000 x 6/12 x 30%) Interest acquired (30,000/100,000)

180,000 30%

2. On April 1, 2018, Ben Company purchased 40% of the outstanding ordinary shares of Clarke Company for P10,000,000. On that date, Clarke’s net assets were P20,000,000 and Ben cannot attribute the excess of the cost of its investment in Clarke over its equity in Clarke’s net assets to any particular factor. The investee’s net income for 2018 is P5,000,000 What is the maximum amount which could be included in 2018 income before tax to reflect the “equity in net income of investee”? a. 1,400,000 b. 1,500,000 c. 2,000,000 d. 1,850,000 Solution 2 – Answer b Share in net income from April 1 to December 31, 2018 (5,000,000 x 9/12 x 40%) Acquisition Cost Carrying amount of net assets acquired (40% x 20,000,000) Goodwill – not amortized

1,500,000 10,000,000 (8,000,000) 2,000,000

Questions 3 - 5 are based on the following information: At the beginning of current year, Ronald Company purchased 40% of the outstanding ordinary shares of New Company, paying P6,400,000 when the carrying amount of the net assets of New Company equaled P12,500,000. The difference was attributed to equipment which had a carrying amount of P3,000,000 and a fair market value of P5,000,000 and to building which had a carrying amount of 2,500,000 and a fair market value of P4,000,000. The remaining useful life of the equipment and building was 4 years and 12 years, respectively. During the current year, New Company reported net income of 5,000,000 and paid cash dividend of P2,500,000. 3. What is the excess of cost over the carrying amount of net assets acquired? a. 5,000,000 b. 1,400,000 c. 3,000,000 d. 0 Solution 3 – Answer b Acquisition Cost Net assets acquired (40% x 12,500,000) Excess of cost Excess attributable to equipment (40% x 2,000,000) Excess attributable to building (40% x 1,500,000)

6,400,000 (5,000,000) 1,400,000 800,000 600,000 1,400,000

4. What amount should be reported as investment income for the current year? a. 2,000,000 b. 1,000,000 c. 1,800,000 d. 1,750,000 Solution 4 – Answer d Share in net income (40% x 5,000,000) Amortization of excess: Equipment (800,000 /4) Building (600,000 /12) Investment income

2,000,000 (200,000) (50,000) 1,750,000

5. What is the carrying amount of the investment in associate at year end? a. 6,400,000 b. 8,150,000 c. 7,150,000 d. 7,400,000 Solution 5 – Answer c Acquisition cost Investment income Cash dividend received (40% x 2,500,000) Carrying amount of investment in associate

6,400,000 1,750,000 (1,000,000) 7,150,000

6. On January 1, 2015, Bart Company acquired as a long term investment for P7,000,000, a 40% interest in Hall Company when the fair value of Hall’s net assets was P17,500,000. Hall Company reported the following net losses: 2015 2016 2017 2018

5,000,000 7,000,000 8,000,000 4,000,000

On January 1, 2017, Bart Company made cash advances of P2,000,000 to Hall Company. On December 31, 2018, it is not expected that Bart Company will provide further financial support for Hall Company. What amount should be reported as loss from investment for 2018? a. 1,600,000 b. 4,000,000 c. 1,000,000 d. 600,000 Solution 6 – Answer c Original cost Cash advances Total investment Net loss from 2015 to 2017 (40% x 20,000,000) Carrying amount of investment – December 31, 2017

7,000,000 2,000,000 9,000,000 (8,000,000) 1,000,000

Share in net loss of 2018 (40% x 4,000,000)

1,600,000

Loss to be reported in 2018 should be equal to the investment balance only

1,000,000

Questions 7 - 10 are based on the following information: Alpha Company acquired 20,000 shares of Beta Company on January 1, 2018 at P120 per share. Beta Company had 80,000 shares outstanding with a carrying amount of P8,000,000. The difference between the carrying amount and fair value of Beta Company on January 1, 2018 is attributable to a broadcast license which is an intangible asset. Beta Company recorded earnings of P3,600,000 and P3,900,000 for 2018 and 2019, respectively, and paid per share of P16 in 2018 and P20 in 2019. Alpha Company has a 20-year straight line amortization policy for the broadcast license. 7. What is the investment income for 2018? a. 900,000 b. 880,000 c. 320,000 d. 920,000 Solution 7 – Answer b Acquisition Cost (20,000 x 120) Net assets acquired (25% x 8,000,000) Excess of cost Share in net income for 2018 (25% x 3,600,000) Amortization of excess for 2018 (400,000 / 20) Investment income for 2018 Interest acquired (20,000 shares / 80,000 shares)

2,400,000 (2,000,000) 400,000 900,000 (20,000) 880,000 25%

8. What is the carrying amount of the investment in associate on December 31, 2018? a. 2,980,000 b. 2,960,000 c. 3,300,000 d. 2,060,000 Solution 8 – Answer b Acquisition Cost Investment income Share in cash dividend for 2018 (20,000 x 16) Carrying amount of investment

2,400,000 880,000 (320,000) 2,960,000

9. What is the investment income for 2019? a. 975,000 b. 995,000 c. 955,000 d. 935,000 Solution 9 – Answer c Share in net income for 2019 (25% x 3,900,000) Amortization of excess for 2019 Investment income for 2019

975,000 (20,000) 955,000

10. What is the carrying amount of the investment in associate on December 31, 2018? a. 3,515,000 b. 2,400,000 c. 3,555,000 d. 4,275,000 Solution 10 – Answer a Carrying amount – December 31, 2018 Investment income for 2019 Share in cash dividend for 2019 (20,000 x 20) Carrying amount – December 31, 2019

2,960,000 955,000 (400,000) 3,515,000

Questions 11-12 are based on the following information: Blue Company purchased 10% of Tot’s Company’s 100,000 outstanding shares on January 1, 2018 for P500,000. On December 31, 2018, Blue Company purchased an additional 20,000 shares of Tot’s Company for P1,500,000. Tot Company had not issued any additional shares during 2018. The investee reported earnings of P3,000,000 for 2018. The fair value of the 10% interest is P900,000 on December 31, 2018. 11. What is the carrying amount of the investment in associate on December 31, 2018? a. 2,300,000 b. 2,000,000 c. 2,400,000 d. 2,900,000

Solution 11 – Answer c Fair Value of 10% interest Cost on December 31 (20,000 / 100,000 shares = 20%) Carrying amount – December 31, 2018

900,000 1,500,000 2,400,000

12. What total amount of income should be recognized for 2018? a. 500,000 b. 400,000 c. 900,000 d. 0 Solution 12 – Answer b Fair Value of 10% interest Acquisition cost of 10% interest Gain on measurement to equity

900,000 500,000 400,000

13. At the beginning of current year, Well Company purchased 10% of Rea Company’s outstanding shares for P4, 000,000. Well Company is the largest single shareholder in Rea and Well’s officers are a majority of Rea’s board of directors. The investee reported net income of P5, 000,000 for the current year and paid cash dividend of P1,500,000. What amount should be reported as investment in Rea at year-end? a. 4,500,000 b. 4,350,000 c. 4,000,000 d. 3,850,000 Solution 13 – Answer b Acquisition, January 1 Add: Share in net income (10% x 5,000,000) Total Less: Share in cash dividend (10% x P1,500,000) Carrying amount of investment, December 31

4,000,000 500,000 4,500,000 150,000 4,350,000

Questions 14-16 are based on the following information: At the beginning of current year, Anne Company purchased 20% of the outstanding ordinary shares of Dune Company for P4,000,000, of which P1,000,000 was paid in cash and P3,000,000 is payable with 12% annual interest at every year-end. Dune Company’s shareholders’ equity at the beginning of current year was P13,000,000. Anne Company also paid P500,000 to a business broker who helped find a suitable business and negotiated the purchase. At the time of acquisition, the fair values of Dune Company’s identifiable assets and liabilities were equal to their carrying amounts except for an office building which had a fair value in excess of carrying amount of P2,000,000 and an estimated life of 10 years. During the current year, Dune Company reported net income of P5,000,000 and paid cash dividend 0f P2,000,000. 14. What is the implied goodwill from the acquisition? a. 1,900,000 b. 1,000,000 c. 1,500,000 d. 0 Solution 14 – Answer c Purchase Price Broker fee Acquisition cost Carrying amount (20% x 3,000,000) Excess of cost Excess attributable to building (20% x 2,000,000) Excess attributable to goodwill – not amortized

4,000,000 500,000 4,500,000 (2,600,000) 1,900,000 (400,000) 1,500,000

15. What amount of income should be reported for the current year as a result of the investment? a. 810,000 b. 620,000 c. 960,000 d. 885,000 Solution 15 – Answer c Share in net income (20% x 5,000,000) Amortization of excess of cost: Attributable to building (400,000 / 10) Investment Income

1,000,000 ( 40,000) 960,000

16. What is the carrying amount of the investment in associate at year-end? a. 4,560,000 b. 4,160,000 c. 5,060,000 d. 5,460,000 Solution 16 – Answer c Acquisition cost Investment Income Cash dividend (20% x 2,000,000) Carrying amount

4,500,000 960,000 (400,000) 5,060,000

17. Moss Company owned 20% of Dubro Company’s preference share capital and 50% of the ordinary share capital. The investee reported net income P600,000 for the current year. 10% cumulative preference share capital Ordinary share capital

1,000,000 7,000,000

What is the investment income for the current year? a. 270,000 b. 300,000 c. 350,000 d. 250,000 Solution 17 – Answer d Net income Preference dividend (10% x 1,000,000) Net income to ordinary shares Share in net income – ordinary shares (50% x 500,000)

600,000 (100,000) 500,000 250,000

18. At the beginning of current year, Alpha Company acquired 40% of the outstanding ordinary shares of an investee for P6,500,000. The carrying amount of the net assets of the investee equaled P12,500,000. Any excess of cost over carrying amount is attributable to goodwill. The investee reported net loss of P4,000,000 and paid cash dividend of P2,500,000. What is the carrying amount of the investment at year-end? a. 6,500,000 b. 3,900,000 c. 4,900,000 d. 5,500,000

Solution 18 – Answer b Acquisition cost Share in net loss (40% x 4,000,000) Share in cash dividend (40% x 2,500,000) Carrying amount of investment in associate

6,500,000 (1,600,000) (1,000,000) 3,900,000

Questions 19-21 are based on the following information: On January 1, 2018, Forensic Company acquired a 10% interest in an investee for P3,000,000. The investment was accounted for using the cost method. On January 1, 2019, the entity acquired a further 15% interest in the investee for P6,750,000. On such date, the carrying amount of the net assets of the investee was P36,000,00 and the fair value of the 10% interest was P4,500,000. The fair value of the net assets of the investee is equal to carrying amount except for an equipment whose fair value exceeds carrying amount by P4,000,000. The equipment has a remaining life of 5 years. The investee reported net income of P8,000,000 for 2019 and paid cash dividend of P5,000,000 on December 31, 2019. 19. What amount of gain on measurement to equity should be recognized for 2019? a. 1,500,000 b. 4,500,000 c. 2,250,000 d. 0 Solution 19 – Answer a Fair value of 10% interest Carrying amount of 10% Gain on measurement to equity

4,500,000 (3,000,000) 1,500,000

20. What is the goodwill arising from the acquisition on January 1, 2019? a. 2,250,000 b. 1,250,000 c. 1,350,000 d. 350,000 Solution 20 – Answer b Fair value of 10% interest Cost of additional 15% interest Total cost of investment Fair value of net assets acquired (25% x 36,000,000) Excess of cost Excess attributable to equipment (25% x 4,000,000) Goodwill

4,500,000 6,750,000 11,250,000 9,000,000 2,250,000 1,000,000 1,250,000

21. What is the carrying amount of investment in associate on December 31, 2019? a. 11,250,000 b. 11,800,000 c. 12,000,000 d. 14,300,000 Solution 21 – Answer b Total cost of investment – January 1, 2019 Investment income Share in cash dividend (25% x 5,000,000) Carrying amount – December 31, 2019

11,250,000 1,800,000 (1,250,000) 11,800,000

Share in net income (25% x 8,000,000) Amortization of excess (1,000,000 /5) Investment income

2,000,000 (200,000) 1,800,000

22. Seiko Company had 100,000 ordinary shares outstanding. Globe Company acquired 30,000 shares of Seiko for P120 per share in 2016 representing 30% interest. Changes in retained earnings of Seiko are: Retained earnings (deficit), January 1, 2018 Net income for 2018 Retained earnings, December 31, 2018 Net income for 2019 Cash dividend paid on December 31, 2019 Retained earnings, December 31, 2019

(500,000) 700,000 200,000 800,000 (400,000) 600,000

What is the carrying amount of the investment in associate on December 31, 2019? a. 3,600,000 b. 3,930,000 c. 3,780,000 d. 4,080,000 Solution 22 – Answer c Acquisition Cost (30,000 x 120) Deficit on January 1, 2018 (30% x 500,000) Carrying amount of investment – January 1, 2018 Net income for 2018 (30% x 700,000) Net income for 2019 (30% x 800,000) Cash dividend on 12/31/2019 (30% x 400,000) Carrying amount of investment – December 31, 2019

3,600,000 (150,000) 3,450,000 210,000 240,000 (120,000) 3,780,000

Questions 23-25 are based on the following information: At the beginning of the current year, Sage Company bought 40% of Eve Company’s outstanding ordinary shares for P4,000,000. The carrying amount of Eve’s net assets at the purchase date totaled P9,000,000. Fair values and carrying amounts were the same for all items except for plant and inventory, for which fair values exceeded their carrying amounts by P900,000 and totaled P100,000, respectively. The plant has an 18-year life. All inventory was sold during the current year. During the current year, the investee reported net income of P1,200,000 and paid a P200,000 cash dividend. 23. What is the excess of cost over the carrying amount of net assets acquired? a. 360,000 b. 400,000 c. 500,000 d. 0 Solution 23 – Answer b Acquisition cost Net assets acquired (40% x 9,000,000) Excess of cost over carrying amount

4,000,000 (3,600,000) 400,000

24. What amount should be reported as investment income for the current year? a. 480,000 b. 420,000 c. 360,000 d. 320,000 Solution 24 – Answer b Share in net income (40% x 1,200,000) Less: Amortization of excess of cost Depreciation of plant (360,000 / 18) Inventory (totally sold) Investment Income

480,000 20,000 40,000

25. What is the carrying amount of the investment in associate at year-end? a. 4,400,000 b. 4,420,000 c. 4,340,000 d. 4,220,000

60,000 420,000

Solution 25 – Answer c Acquisition cost Investment income Cash dividend (40% x 200,000) Excess of cost over carrying amount

4,000,000 420,000 ( 80,000) 4, 340,000